The Organization of Health Insurance Markets Chapter 11

Dr. Katie Sauer Health Economics

Outline: I. Loading Costs II. Employer-Provided Health Insurance and Demand III. Employer-Provided Health Insurance and Labor Supply IV. The Uninsured ____________________________________________________________________ I. Loading Costs Consumers can improve their well-being by sacrificing a (relatively) small but certain premium to insure against the probability of a considerably larger loss. It is important to examine how the policies will be offered to specific groups. (why some groups will find it difficult to get insurance at all) Insurance firms incur costs of doing business that are added to the claims payouts. These loading costs are largely related to the numbers and types of customers and claims processed. - must be passed on to consumers in order for insurers to cover their costs How much are people willing to pay for insurance? When the probability of being well is 100%, then there are no gains from insurance. When the probability of being sick is 100%, then there are no gains from insurance. - might as well set money aside Some events can substantially reduce wealth. - heart attack Some events wont substantially reduce wealth. - hang nail The expected utility line will reflect that. The horizontal distance between the certainty utility curve and the expected When comparing types of losses at any given probability, the marginal gain from loss, the utility curve is the larger the expected larger the gain from insurance. insurance. hangnail vs heart attack The marginal gains increase, then decrease. When the marginal gains to the consumer exceed the insurers marginal cost, insurance coverage will exist.

This analysis provides one avenue for addressing the problem of the uninsured. It is apparent that the per-person costs of processing information and claims of those individuals who are outside larger organizations (either companies or unions) may be higher. This would result in an increase in the insurance firms marginal costs relative to the consumers marginal benefits and would reduce or eliminate the range of services that may be offered. II. Employer-Provided Health Insurance and Demand The largest segment of the American population acquires health insurance through the workplace. A. Labor Market Assume a lower money wage rate leads to firms hiring more workers. Employers will hire workers as long as the incremental (marginal) revenue from the goods those workers produce exceeds the per hour wage. Suppose that workers negotiate a health insurance benefit worth $1 per hour to them, and costing exactly $1 for the employer to provide.

The employer, who was previously willing to pay a wage of $20, will now be willing to pay $20 less the $1 cost. The workers are no worse off at a wage of $19 with the health insurance than at $20 without the health insurance because the insurance is worth the $1 that it cost in reduced wages. The employer earns no less profit for providing the health benefit. Initially: market clears at wage W1 with L1 employees B. Spousal Coverage Suppose a town has two employers, firm A and firm B. A employs only married men. With B. Half of their spouses work atInsurance Benefit: Labor Demand is reduced by $z. Half of their spouses do not work. Labor Supply increases by $z. Market clears at wage W2 with L1 employees B employs married women and singles. Half are the spouses of firm A employees. Half are single. The wage in each firm is $50,000. Firm A offers to buy family coverage worth $4000. Firm B offers to pay $2000 per person, as long as those who want insurance pay $10 a month. All workers will receive the same take-home pay regardless of insurance cost. In firm A, who will buy insurance? Men with non-working spouse:

Men with working spouse:

In Firm B, who will buy insurance? Women with working spouses:

Singles:

So who really pays for insurance? C. Tax Treatment One of the most important factors in the increased demand for health insurance has been its tax treatment. John earns $1000 per week. He is taxed at 28%. Insurance costs $60 per week.

If John pays for the insurance out-of-pocket: weekly income = Suppose Johns employer purchases the insurance for him. This fringe benefit is exempt from taxation. Johns employer will reduce his monetary wages: His total compensation package is still $1000: His after-tax income is Compare this with the disposable income he has if he buys the insurance himself. As marginal tax rates rise, consumers are better off having their employer pay for health insurance. Employers also benefit because they pay less in Social Security and Medicare taxes. - insurance is treated as an expense to the employer Because health expenditures have been chosen for special tax treatment, there exists an allocative problem within the economy.

Initially: MN is constraint U0 is utility and I0 is optimal amount of insurance. Employer sponsored insurance lowers the wage but increases the amount of insurance that can be consumed. MN The new optimal amount of insurance coverage is I1.

The tax treatment of health insurance benefits to employees amounts to a subsidy for employees. -results in the purchase of more health insurance than in the absence of the subsidy Two major potential impacts of employer-based health insurance relate to retirement age and job mobility. III. Employer-based insurance and labor supply A. Retirement Age Gruber and Madrian (2002) show that compared with those age 35 to 44, those age 55 to 64 are: -twice as likely to report themselves in fair health -four times as likely to report themselves in poor health -seven times as likely to have had a heart attack -five times as likely to have heart disease -40 percent more likely to have a prescribed medicine (with twice as many medicines if receiving a prescription) Gruber and Madrian summarize 16 studies and report that the availability of retiree health insurance raises the odds of retirement by between 30 and 80 percent. B. Worker Mobility Employer provided health insurance may create job lock which may have several economic effects:

1. Less productive workers may stay at jobs for insurance reasons only, leading to decreased economic output because they would not be replaced by more productive workers. 2. Even if all workers are equally productive, some workers may stay in jobs for fear of losing the health insurance benefits to the exclusion of those who would otherwise fill the jobs. 3. Those who do change jobs may be denied coverage, face higher premiums, or only obtain insurance subject to a waiver that excludes coverage of their health condition. The empirical evidence generally shows that employer provided health insurance adversely affects job mobility. IV. The Uninsured -The number of uninsured in the US is always an estimate. -Various surveys have shown that over 45 million Americans have no health insurance at any moment in time. -In 2006, 3 out of every 8 families with annual incomes below $20,000 had no health insurance. -27% of those ages 2534 were uninsured in 2006. -In the 35-to-44 age range 18.9% were uninsured in 2006. -Of the 29.6 million people working in firms with 25 or fewer employees, about 9.7 million people (33%) were uninsured. A. The working uninsured Barriers to small business provision of health benefits: - affordability (low profit margins, low wages, and high premiums) wn = net wage - insurance redlining or pre-existing condition clauses (high turnover, seasonal w = monetary wage workforce, commission workforce, = insurance benefit i lawyers, physicians) wn0 = w0 +i0 - attitudes (not interested because too complicated) Suppose that insurance benefits are mandated to be B. Mandated Coverage Effects i1, which is larger than io. 1. firms stop offering insurance 2. firms hire fewer workers If the firm still pays a money wage of wo, then the net wage will rise and the firm will hire fewer workers. If the firm instead keeps the net wage constant, then the money wage will fall. - households will have less $ for other goods (insurance crowds out